USD/JPY Outlook: Bulls have the upper hand after BoJ retains ultra-easy policy settings

• USD/JPY gained some traction after the BoJ announced its decision, though lacked follow-through.
• Receding bets for a 100 bps Fed rate hike in July weighed on the USD and capped gains for the pair.
• The Fed-BoJ policy divergence, bullish flag breakout support prospects for some meaningful upside.

The USD/JPY pair refreshed its weekly high during the Asian session on Thursday after the Bank of Japan announced its policy decision, though struggled to capitalize on the move beyond the mid-138.00s. As was widely expected, the central bank defied the global tightening trend and stuck to its ultra-easy policy settings. The BoJ reiterated its commitment to continue buying the Japanese Government Bonds (JGB) at an annual pace of around ¥80 trillion. This, in turn, weighed on the Japanese yen and offered some support to the major, though the emergence of fresh US dollar selling kept a lid on any meaningful upside.

The USD struggled to capitalize on the previous day's bounce from its lowest level since July amid receding bets for a more aggressive rate hike by the Federal Reserve in July. It is worth recalling that several FOMC members said last week that they will likely stick to a 75 bps rate increase at the upcoming meeting on July 26-27. This, in turn, forced investors to scale back their expectations for a supersized 100 bps rate hike move, which continued acting as a headwind for the greenback. That said, elevated US Treasury bond yields should limit deeper losses for the USD and lend some support to the USD/JPY pair.

Investors still seem convinced that the recent surge in US consumer inflation to a four-decade high would force the Fed to deliver a larger rate hike later this year. The resultant widening of the US-Japan rate differential, along with a modest recovery in the global risk sentiment, could undermine the safe-haven Japanese yen. The fundamental backdrop favours bullish traders and supports prospects for the resumption of the USD/JPY pair's strong uptrend. Market participants now look forward to the US economic docket - featuring the release of the Philly Fed Manufacturing Index and the usual Weekly Initial Jobless  Claims. Apart from this, the US bond yields would influence the USD and provide some impetus to the major.

Technical outlook

From a technical perspective, this week's breakout through a descending channel, which constituted the formation of a bullish flag pattern, adds credence to the positive outlook. Some follow-through buying beyond the daily swing high, around the 138.50-138.55 region would reaffirm the bullish bias and allow the USD/JPY pair to reclaim the 139.00 mark. Bulls might eventually aim to challenge a 24-year high, around the 139.40 region touched last week.

On the flip side, the 200-hour SMA, currently near the 137.90-137.85 zone, now seems to protect the immediate downside ahead of the descending channel resistance breakpoint, around the 137.60 area. This is followed by the 137.40-137.35 region, or the weekly low, which coincides with the 38.2% Fibonacci retracement level of the 134.25-139.39 rally. Failure to defend the said levels would make the USD/JPY pair vulnerable to breaking below the 137.00 mark and expose the 136.80-136.75 confluence support. The latter comprises 50% Fibo. level and the lower end of the aforementioned channel, which if broken would shift the near-term bias in favour of bearish traders.